The earnings of banks could be significantly affected if the draft norms are implemented. Photo: Ramesh Pathania/Mint

Updated: Fri, Feb 01 2013. 12 50 PM IST

Mumbai: The Reserve Bank of India (RBI) proposed on Thursday that banks make provisions to cover 5% of their restructured loans starting 1 April instead of the current 2.75%, which could have a significant impact on their earnings if implemented.

Not only that, the draft norms also suggested that the provisions on the stock of total restructured loans should be hiked to 5% in a phased manner—to 3.75% with effect from 31 March 2014, and 5% with effect from 31 March 2015.

The central bank has sought comments on the suggestions by 28 February. The guidelines, if accepted, could make it more difficult for indebted companies trying to persuade banks to restructure loans. The panel is headed by B. Mahapatra, executive director, RBI.

In November last year, RBI raised the provisioning for restructured loans to 2.75% from 2%. This increase dragged down profits of all bank in the third quarter ended December. For example, Central Bank of India, which has the highest share of bad loans as a percentage of total loans in the industry, took a hit of Rs.150 crore in its third-quarter profit.

Total loans restructured by Indian banks under the so-called corporate debt restructuring (CDR) route crossed Rs.2 trillion in December. In the past quarter alone, banks restructured Rs.24,584 crore of loans, up from the Rs.19,544 crore they recast in the previous quarter, to reach Rs.2.12 trillion of restructured loans.

The actual figure for restructured loans may be around Rs.4 trillion as this estimate does not include bilateral restructuring cases that banks undertake individually with firms.

“About 5.9% of the loan book in the banking system has been restructured as of September 2012, which is about Rs.3 trillion. Right now, at 2.75% provision, banks have to set aside just below Rs.9,000 crore; but if these norms kick in from the next fiscal, they will have to set aside another Rs.3,000 crore, going up to Rs.6,750 crore in two years,” said Krishnan.

“These new guidelines, if applied, will disincentivize banks from inordinate restructuring because they will have to pay a higher cost on restructured loans,” he said. “Increasing the provision to 5% will bring the cost of restructuring almost on par with bad loans because when a loan goes into CDR, banks typically take a loan-to-value hit of 10% to 15%. A 5% provision on these loans will mean the cost will be almost equal to a bad loan.”

Bankers have already protested against some of the recommendations of the RBI panel earlier.

“The recommendations of the committee are not easy to implement. Banks have already spoken against this committee’s recommendations with the regulator,” said a banker who requested anonymity. “Profitability will be hampered and it will not allow us to restructure loans of firms that are genuinely in need.”

If the suggestions are accepted by RBI, India’s highly leveraged realty sector is likely to be the worst affected. Already, RBI has denied banks permission to restructure loans of companies belonging to the segment. However, they can still restructure the loans of real estate companies as with any other account, on a case-by-case basis.

Any increase in provisioning will have a significant effect, especially since banks will have recast more loans in the approaching months given the slow pace of recovery in India’s economic growth, analysts said.

Under CDR, commercial banks typically stretch the repayment period to stressed companies, offer a moratorium and reduce lending rates, among other measures. Under current norms, banks are required to make 2.75% provisioning on standard restructured loans as against 0.4% for loans that are standard.

In the event of a restructured loan turning bad, the provisioning liability shoots up to 15%.

The current situation could turn worse as most analysts suspect that 25-30% of the restructured loans may turn bad, unless there is a significant revival in the economy.

Bad loan levels in the banking system have spiked in the past few years because of a slowing economy.

Gross non-performing assets (NPAs) of 40 listed Indian banks rose to Rs.1.66 trillion in September, up 46.8% from a year-ago period.

In the December quarter, gross NPAs of 28 listed banks, which have so far reported results, have together accounted for Rs.93,748.07 crore. Some big banks, including State Bank of India (SBI) and Bank of Baroda, are yet to announce results.

Among the large banks that have the maximum amount of NPAs are the nation’s largest lender SBI (5.15%) and Central Bank of India (5.64%).